Quarterly Market Update: 2023 Q3

Market Summary

Disinflationary trends helped the equity markets continue their gains in the second quarter of 2023. Inflation’s pace of growth slowed down enough for the Federal Reserve to leave rates unchanged in June with the expectation of two small increases for the rest of the year. This helped rate-sensitive equity investments continue to rally, sending the technology-heavy NASDAQ Composite Index up 32.32% for the first half compared to the broader market’s 16.26% gain. Although the Dow Jones U.S. Total Stock Market Index is comprised of over 4000 stocks, the top ten companies make up more than a quarter of the benchmark and they are heavily concentrated in the technology sector. On the surface, it may seem like a broad rally for all sectors, but the bulk of the gains have been contributed by large, mega-cap (over $200 billion market capitalization) stocks like Apple and Microsoft. Fixed income prices declined slightly in the second quarter as the Fed continued to raise rates, although less aggressively, and perhaps by the flow of money going back into risk assets.

INDEXASSET CLASS2023 YTD
DJ U.S. TOTAL STOCK MARKETU.S. STOCKS16.26%
MSCI AC WORLD EX-USAINTERNATIONAL STOCKS9.61%
BLOOMBERG U.S. AGGREGATE BONDBONDS2.09%
Market returns year to date as of 06/30/2023

At the end of Q1, the S&P 500’s forward price earnings ratio stood at 17.81x. By June 30th, it had risen to 19.13x. Investors piled into the equity markets with renewed fervor, hoping the Fed would be done with their aggressive monetary tightening policy sometime this year and possibly stave off a widely predicted recession. Whether or not the Fed can maneuver a soft landing is still to be seen, but further rate increases may be done for this year after none in June and a quarter point hike in July. Although there may not be many more rate increases this year, we are unlikely to see decreases for a while, not until inflation reaches 2% and remains there for a significant period of time.

Source: FactSet, FRB, Refinitiv Datastream, Robert Shiller, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management. 
Price-to-earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months as provided by IBES since June 1998 and by FactSet since January 2022. Current next 12-months consensus earnings estimates are $233. Average P/E and standard deviations are calculated using 25 years of history. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as the next 12-months consensus dividend divided by most recent price. Price-to-book ratio is the price divided by book value per share. Price-to-cash flow is price divided by NTM cash flow. EY minus Baa yield is the forward earnings yield (consensus analyst estimates of EPS over the next 12 months divided by price) minus the Moody’s Baa seasoned corporate bond yield. Std. dev. over-/under-valued is calculated using the average and standard deviation over 25 years for each measure. *P/CF is a 20-year average due to cash flow availability.
Guide to the Markets – U.S. Data are as of June 30, 2023.
Source: FactSet, FRB, Refinitiv Datastream, Robert Shiller, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management.

A Farewell to Inflation?

I’ve addressed the topic of inflation for over two years now and like most investors, I think I’d like to be done with this topic. The downward trend of inflation has lasted a year, since the annualized change in the Consumer Price Index peaked in June 2022 at 9.1%. A year later, we now have a 3% CPI number in June 2023. As a reminder, this doesn’t necessarily mean prices of goods have fallen over the past year, it just means the rate of change has slowed down. This brings the rate of inflation very close to the Fed’s goal of 2%. Although we’ve made tremendous progress in reducing inflation, the final stretch may prove to be tougher to achieve due to some challenges in the labor market and volatile commodity prices.

The labor market continues to be strong with a 3.6% unemployment as of June. We have a tight labor market when job openings are plentiful and workers are scarce, which drives up the cost of hiring and retaining employees. The good news is the participation rates for younger workers has rebounded back to or above pre-COVID levels. However, workers over the age of 55 have not returned to the workforce as quickly, and in fact, their participation rate has dropped from 40.3% in February 2020 to 38.3% in June 2023.

Food staples like wheat and rice may see a spike in prices as the Ukraine-Russia war continues on and India has banned the export of certain types of rice. Russia’s attack on a Ukrainian port defies a deal that allowed ships to safely transport grains from Ukraine. Meanwhile in India, non-basmati white rice is banned from being exported globally. Indian accounts for 40% of the global rice trade and is the second-largest producer after China.

The Rise of Artificial Intelligence

Artificial Intelligence (AI) has seemingly become the hottest buzzword overnight, but in reality, it’s taken years and decades to reach this point. I consider OpenAI’s ChatGPT to be a key contributor in sparking interest in this disruptive technology. When ChatGPT became available for public use less than a year ago, users were able to use natural written language to instruct the application to do a myriad of tasks including answering questions, writing essays, and even creating computer code.

I asked ChatGPT to “write a paragraph describing AI and ChatGPT as a disruptive technology” and it created the following paragraph in less than 2 seconds:

AI, particularly exemplified by ChatGPT, stands as a remarkable disruptive technology that has reshaped the landscape of human-computer interactions. With its unprecedented capacity for natural language processing, ChatGPT has revolutionized the way individuals communicate and seek information. As an innovative language model, it possesses the ability to comprehend and generate human-like text, making it appear remarkably lifelike in its responses. This groundbreaking technology has found applications in various domains, transforming customer service, content creation, and even personalized virtual assistants. The advent of AI and ChatGPT has redefined the boundaries of what machines can achieve, catalyzing progress and efficiency across industries, and fostering a new era of dynamic and immersive digital interactions.

While ChatGPT’s writing style is not necessarily the style in which I write, it would be near impossible to know that paragraph was not written by a human being. ChatGPT is a text based application, but there are numerous other AI programs can do other tasks like creating artwork or driving autonomously. OpenAI is a private company, but has large investors like Microsoft, who has started integrating ChatGPT into their Bing search engine. Many of the mega-cap companies like Alphabet and Tesla have their own artificial intelligence technologies and those companies that don’t have their own will end up buying or licensing them. AI’s potential for good is enormous, but it doesn’t come without criticism and concern. It can be something more trivial like students using it to write their essays or something more serious like takings over jobs and tasks that humans are currently doing.

Looking Forward

It appears like exuberance may be making a come back in the markets as technology stocks are performing well and the Federal Reserve begins to relax on their monetary tightening. Higher asset prices pushed up valuations and now corporate earnings need to beat expectations in order to justify these elevated levels. However, high interest rates and weaker purchasing power present challenges for companies as well as consumers. What’s helping the U.S. consumer though is record-high net worth, excess savings, and strong wage growth. Although risk asset prices can continue to go higher, it wouldn’t be surprising to see some pullback and increased volatility in Q3. The CBOE Volatility Index (VIX) is sitting at levels we haven’t seen since pre-COVID, which could indicate a high level of complacency or the beginning of irrational exuberance.

Wei Trieu, CFP®

View posts by Wei Trieu, CFP®
Wei Trieu is the founder and wealth advisor of Key Focus Wealth. He is a CERTIFIED FINANCIAL PLANNER™ professional who works directly with clients to develop and implement financial plans.
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